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01 May 2020

COVID-19: Insolvent trading provisions


4 min

What directors must understand about the temporary relief.

Directors must be conscious of how their company incurs debts in the COVID-19 environment. While the government has given a reprieve on insolvent trading until 25 September 2020, it’s unclear on which debts are protected under the insolvent trading provisions and directors’ personal liability for any claim made post-COVID-19.

Before this crisis, the insolvent trading law was clear-cut under section 588G of the Corporations Act 2001 (director’s duty to prevent insolvent trading by a company). It states that a company director can be personally liable for debts the company incurs if at that time, “reasonable grounds” could make directors suspect the company was already insolvent or would be insolvent due to this debt being incurred.

Following the crisis, section 588GAAA of the Corporations Act was introduced on 23 March 2020 with the passing of the Coronavirus Economic Response Package Omnibus Bill 2020 by Federal Parliament. The section says that a director will not be personally liable for insolvent trading in respect of a company debt, if incurred:

  • in the ordinary course of the company’s business

  • during the six-month period from 25 March 2020 to 25 September 2020, or any longer period the regulations prescribe.

The question is, given the wildly uncertain COVID-19 business environment, what constitutes “the ordinary course of the company’s business”. Clearly, nothing is ‘ordinary’...

Directors and their advisors must remember the overarching goal of these government measures—to provide temporary relief and support business survival if possible and appropriate. As a guide, the government has outlined:

A director is taken to incur a debt in the ordinary course of business if it is necessary to facilitate the continuation of the business during the six-month period”. 

Examples include:

  1. “A director taking out a loan to move some business operations online.” 

  2. “Debts incurred through continuing to pay employees during the coronavirus pandemic”. 

loansIn these examples the incurring of the debt appears to be correlated to actions being taken to overcome business conditions arising from the impact of COVID-19. This demarcation of debts incurred for distinct purposes may be critical when directors could decide to recapitalise their business to holistically deal with and fund a range of business operations. Would a refinanced loan (incurred debt) be pardoned in an insolvent trading claim if the company is put into liquidation post-COVID-19? Remembering that liquidators can make an insolvent trading claim in the six years that follow the liquidation’s commencement. And that it applies to directors in office—whether formally appointed or not—at the time of the debt being incurred, and not just the directors at the time of the liquidation.

The short answer is that we don’t know.

What we do know is that with this temporary reform and relief does not absolve company directors’ from continuing to comply with their duties, including:

  • exercising care and diligence

  • taking steps to be properly informed about the company’s financial position

  • exercising powers in good faith (company’s best interests and proper purpose

  • not improperly using their position/information to gain advantage or cause detriment to the company

  • keeping adequate books and records

  • complying with obligations to assist an administrator, liquidator, or controller (if appointed)

  • complying with tax reporting obligations (other government measures are contingent on these being fulfilled).

Critically, any debts incurred will still be payable by the company and criminal penalties still apply to egregious cases of dishonesty, illegal phoenix activity, and fraud. Directors should also be cognisant that the Director Penalty Regime still applies in respect of the pay as you go (PAYG) withholding, luxury car tax (LCT), wine equalisation tax (WET), goods and services tax (GST) and superannuation.

No matter what the business challenge directors are facing, this business environment is daunting. The Worrells partners and staff are available to assist business owners that find themselves in a distressed position. We are experts in providing restructuring advice and can provide the guidance that may be needed in these difficult times.

For more information on the insolvent trading provisions, our factsheet click here, explains the following factors:

  • What is insolvent trading?

  • Why do liquidators make these claims?

  • Who makes insolvent trading claims?

  • Can creditors take insolvent trading action?

  • What are the factors in an insolvent trading claim?

  • Who are directors?

  • When is a company insolvent?

  • What about accrued debts

  • How do directors become liable for insolvent trading claims?

  • What defences are available to directors?

  • Is insolvent trading an offence?

  • How long do liquidators have to take action for insolvent trading?

  • What should directors do if a liquidator makes an insolvent trading claim?

Related articles:

Government economic response—new insolvency rules

Insolvent Trading Revisited

The effectiveness of the safe harbour regime


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